Daily Market Brief

Royal Flush

flushI’ll start today with a trading lesson: This last week has been phenomenal from a trading perspective, if you were on the right side of the trade that is. It’s pretty clear that most people got caught wrong footed and trapped in either direction quite a few times. First on the false breakout last Friday and vicious decline that followed into Monday. Then on the subsequent bounce into Wednesday that gave the all clear sign to many as evidenced by the low CPC ratio I pointed out yesterday. And then finally yesterday’s decline was completely unexpected in terms of size for most and I have no doubt that great damage was inflicted on many accounts. Having been fortunate to be able to ride these turns in perfect precision amounts to what is called in poker terms a Royal Flush. Not to liken what I do to poker, but it includes certainly one key ingredient: Nerves.

As you know I consider trading psychology to be the central binding ingredient to trading and as a human being I’m not exempt from emotions, yet over the years I’ve learned how to read, manage, and control them. After an extreme market event like yesterday I like to go back and re-evaluate how I managed the action from an emotional perspective and I want to briefly highlight a few tweets of what went really right in terms of reading and reacting to the action yesterday as I firmly believe it is a critical trading lesson for everyone. Volatile markets can make or break accounts after all.

First the context: As you know I had outlined my ideal scenario and while that call turned out to be on the money I surely couldn’t know for certain that this would work out this way as it was a pretty far out call on Tuesday morning:


The challenge was of course to see whether the market would break the box or not as it would have vastly different implications on how to trade and position the rest of the day. So the key was to read the tape and to manage excitement that I felt oncoming, which is always a big warning flag. In fact, I saw people buying the dip and longing the action. While I placed a small $SPY hedge and took off one short position I remained firmly convicted on the short side waiting for the break:


Once we got the break, the temptation was to cover shorts and go long for that infamous ‘fake-out’. Letting winners ride is a key to profit management. This is a moment where you don’t look at your P&L but at the chart and your trade plan and we knew the break out of the box was a meaningful one, so no reason to cover:

Let it Ride

But there is a point when you have to manage discipline, usually that moment is when you get giddy and you have that ‘weeeeeeee’ feeling. And 150 ticks on volatility and a 59 $ES point profit on your position I would argue does qualify. So hence this almost exacerbated tweet from the part of my brain that insists on following process:

Take Profit

But as in poker you are only as good as your next play. And so while things worked out great I have to focus on the signals here. Markets are extremely complex and volatile and to be frank I could make highly convincing arguments as to why markets should fall significantly further from here. And maybe they will, but for now I’m sensing the next play is long again into next week and possibly beyond.

Let me walk you through my rationale:

1. Carnage in tech & small caps. The dance along the key MA’s has followed a stair-step function of testing, bouncing, breaking, retesting, failing and rinse and repeat. Both indices are now below their 100MAs. That’s a significant move and their respective 200MAs and February lows are clear targets. Yet we have to recognize that they are very oversold. Why all the selling? Mix of tapering and seasonal tax selling is my working assumption:


2. $SPX broke the box with the 100MA in clear sight and the 200MA still quite far away,  yet it is clearly in the purview of a corrective target zone. Notice though this move has followed the January correction very closely. That playbook says we would make a low either today or Monday and then rally into OPEX next Friday:


The January fractal alone is not necessarily convincing as markets can deviate from a pattern at any time, but there are several data points that point to a solid bounce coming which brings me to point 3:

3. Weekly $NYSI. I mentioned earlier this week that the weekly $NYSI is getting close to oversold and a new low this week would certainly get it there. It is my view that the weekly chart will show exactly such a reading this weekend:


4. CPC ratio. While I pointed out the silly low reading yesterday morning, I also have to recognize that they flipped on a dime to top reading rather quickly:


5. TICK reading. Extreme tick readings do not occur all that often, but when they do they are notable mainly because they often indicate either selling or buying exhaustion. While not necessarily an imminent turn signal the recent past shows a pretty powerful trend change signal that I can’t ignore:


So what does this all tell me? From my perch it tells me we are closer to the end of this corrective move than the beginning and that another large rally is likely to commence within the next few days. Here’s how I’m playing it:

Trade Plan: Turns are notorious difficult to predict. The $SPX chart clearly indicates more downside to be very likely, but the small caps and tech are much oversold. Yet we knew Thursday/Friday was likely weak due to monthly OPEX expiration so in essence it is following script perfectly. Hence I will close remaining shorts today and scale into longs in futures and calls as well. I’ll be patient and use wide scales to anticipate further weakness to be likely into Monday. Time to be patient and keep exposure tight.







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